Rhode Island Democrats Seek Flat Tax

Rhode Island Democrats Seek Flat Tax
April 1, 2006

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)

Key Democrat lawmakers in Rhode Island have concluded that to keep the state competitive, they need to overhaul the state's tax system, including going from a progressive to a flat-rate income tax for high-income earners.

House Speaker William Murphy (D-West Warwick) and fellow Democratic lawmakers announced in February they believe the state's progressive income tax must be reformed. That reform is part of a package of nine tax initiatives Democrat leaders have offered. Rhode Island's income tax rates range from 3.75 percent to 9.9 percent, one of the highest state income tax rates in the country.

High-income earners would be given the option of paying taxes under the existing tax structure, with its multiple tax rates and income tax deductions and adjustments, or under a new flat-tax structure that eventually will go to a 5.5 percent tax rate without income adjustments available under the existing system.



Takes 'Comprehensive' Approach

"This legislation is a comprehensive approach to providing relief to all taxpayers throughout the state," said Murphy at a news conference where he and other members of the leadership team presented the legislation. "Rather than taking a piecemeal approach to the issues that affect our tax system, we're going to look at how to make the entire system work for the state and for all its taxpayers. The ultimate goal is to put more money directly into people's pockets both by giving relief to those who need it and by making Rhode Island a more attractive place for businesses that will provide high-paying jobs for more Rhode Islanders."

Democrats control both houses of the legislature. The governor, Don Carcieri, is a Republican. Carcieri has told local reporters he welcomes the tax cut and reform proposals.

"We're proposing this for better competition, fairer competition, and trying to attract new business to Rhode Island," said Larry Berman, press secretary to Murphy.



Hope to Lure Business

"What's happening is business leaders have a choice," Berman said. "These are people making $250,000 and above, and when they want to create jobs, they look at Massachusetts and see a 5.3 percent income tax, Connecticut with a 5.0 percent tax, and Rhode Island with a 9.9 percent tax. They make a choice on where to move and create jobs, and that difference in tax rates is a big factor in the choice they make."

The legislation proposes an alternative tax rate that top earners could choose to pay beginning in 2007. Instead of the current rate of 9.9 percent, those taxpayers could choose to pay 7.5 percent of their Adjusted Gross Income (AGI), without any adjustments, deductions, or credits. Over five years, the flat rate would be gradually reduced to 5.5 percent to make it more competitive with the neighboring states. The state would have two systems the current one and the optional flat-tax system. Individual workers would need to determine which system is better for them.



Economic Growth Expected

Berman said a recent survey by the Rhode Island Society of Certified Public Accountants found Rhode Island's high marginal tax rate might be causing retirees and companies to move to states with lower taxes or no income tax. The study also suggested the high tax rate may be causing large companies with multiple locations to put their highest earners somewhere other than Rhode Island.

Peter Marino, director of policy at the Rhode Island Public Expenditure Council, said that definitely is happening.

"Many of our members say they are having trouble recruiting employees with the skills to run their businesses because of our high income tax and property taxes," Marino said. "High-income earners don't want to come here."

Marino said he is "encouraged" by the proposal because it shows a recognition by the state's top lawmakers that Rhode Island's current tax structure needs to be improved and made more competitive. He cautioned, though, that a final bill is probably a long way off.

House Majority Leader Gordon D. Fox (D-Providence) said, "This new tax rate, as it did in Massachusetts, is certain to create new jobs, spur economic development, put money back in taxpayers' pockets, and otherwise bring Rhode Island to a position of twenty-first century economic leadership in the region and, indeed, in the country.

"This will undoubtedly help the state's highest wage-earners," Fox said. "But I am proud that this tax package also helps low-income wage earners and the middle class."



Several Changes Proposed

Other aspects of the legislative package include:

  • Improved income tax transparency. Since Rhode Island began collecting income tax in 1971, the tax has gone from a very simple calculation of the amount paid in federal taxes to a complicated set of laws containing more than 40 different tax credits. This makes the system difficult to understand and compare to other states. Legislation included in the Taxpayer Relief Act of 2006 would require the state's tax administrator to submit recommendations for a Rhode Island Personal Income Tax Code specifying tax rates, income brackets, and personal exemptions.
  • Creation of a new Department of Revenue to collect taxes and tax data. This would provide the state with a continuous review of the tax structure so lawmakers can stay on top of trends and changes and keep Rhode Island's tax laws competitive with those of other states. Rhode Island is the only state in New England without such a department. The department would include the current revenue-generating departments the Division of Taxation, the Division of Lottery, and the Division of Motor Vehicles and a new Division of Property Valuation, which would address the assembly's growing concern over property taxes. It also would include a new Office of Revenue Analysis, which would help the state more quickly identify problems and solutions involving its revenue stream.

Marino said this is an important part of the package, because Rhode Island's tax system is so complicated and diffuse that this information is extremely difficult to obtain.

  • A sales tax holiday weekend on August 12-13, 2006. For the weekend, the bill would exempt items retailing for less than $2,500 from Rhode Island's 7 percent sales tax. Some items, such as tobacco, gasoline, meals, and automobiles, would be excluded from the holiday.
  • Creation of a study commission that would determine whether the state sales tax should be changed. Rhode Island raised its sales tax from 6 to 7 percent in the early 1990s to pay for the bailout of the state's failed credit unions. The change was supposed to be temporary, but it was never rolled back.
  • Changing the state earned income tax credit. A taxpayer who owes the state an amount that is less than the earned income tax credit now gets a refund for 10 percent of the difference. The Taxpayer Relief Act would increase that refund to 15 percent.

Steve Stanek (stanek@heartland.org) is managing editor of Budget & Tax News.

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)